Recapitalization

RECAPITALIZATIONThe Best of All Worlds

A lower middle-market company with a market value of at least $5 million could generate interest in a transaction that is structured as a private company recapitalization (recap). In control to other M&A strategies, a recap provides the owner with additional flexibility and broader range of advantages – both financial and personal.

IMMEDIATE LIQUIDITY

A significant portion of the market value of the business will be paid at closing. This enables the owner to diversify his or her net worth, realize other business or personal goals, or pursue a lifestyle change.

OWNERSHIP RETENTION

By investing part of the proceeds back into the business, the owner retains up to 50% ownership and, in some cases, a majority share in the business. In addition to the continued benefits of ownership, the retained equity in the business ensures a financial stake for the owner in the future potential and profitability of the business.

EXPERIENCED FINANCIAL PARTNER

The business will gain a financial partner, often referred to as a private equity group. These investors are experienced in assisting entrepreneurs to realize their ultimate and long-term goals for the business. Typically, they specialize in investing in industry specific, growth-oriented enterprises, which are most likely to provide maximum return on their investment. They are serious partners who are vitally interested in the potential of the business and committed to its long-term success.

NEW EQUITY CAPITAL

After years of taking risks in order to grow the business, entrepreneurs tend to become more conservative in their decision-making and reluctant in their actions—understandably so, as there is more to lose. Despite this, they know the potential of their business and understand what is necessary to reach that potential. The infusion of new capital by the partner eliminates all personal guarantees by the business owner. It allows the owner to concentrate on taking the business to the next level of growth, unencumbered by the pressure of financial concerns.

OPERATING CONTROL

As the focus of the equity partner is on the future of the business and potential return on investment, its primary interest is to support management in achieving significant growth and profitability. The owner, on the other hand, remains in control of managing day-to-day operations and plays a key role in the implementation of strategies, which will take the business to the next level.

CORPORATE CULTURE

A recapitalization allows the image and corporate culture of the company – carefully nurtured over many years by the owner – to remain intact.

MANAGEMENT PARTICIPATION

A strong senior management team is essential in a recapitalization transaction and, typically, senior management will be given the option to obtain an equity position in the partnership. This serves the needs of the partnership and allows management to participate in the benefits of ownership as a reward for loyal service, and as an incentive to contribute to future growth.

TWO-STEP STRATEGY

Often referred to as “two bites of the apple”, a recapitalization presents a business owner with the opportunity to not only get paid twice, but ultimately much more than in a conventional M&A transaction.

First Payout: The initial payout is at the closing of the transaction, when a significant portion of the market value of the business is realized

Second Payout: This will often exceed the cash received at the initial closing, and will be directly proportionate to original owner’s retained equity. It will occur when the business has achieved a desired level of growth and value, and will be realized through an IPO, acquisition or consolidation

Recapitalization can, in fact, be “the best of all worlds” to an entrepreneur in terms of a liquidity option. In summary, it means: continued operating control, flexible exit choices, the opportunity to realize personal goals for the business and, most importantly, the prospect of maximizing financial gain.

RECAPITALIZATION

Understanding the Investor

In exploring a recapitalization as an appropriate liquidity option, it is essential for a business owner to clearly understand the motivations and expectations of investors.

RETURN ON INVESTMENT

The primary interest of an equity investor is to obtain the highest possible return on investment (ROI). Investment Firms – who may have $100 million to $5 billion in a private investment fund – seek to partner only with successful entrepreneurs with a proven track record.

They will target companies with a specific profile:

Solid historical growth

Strong and consistent profitability

Industry dynamics indicating growth

Willingness of ownership to work with an investor

Ownership objectives aligned with investor goals

Experienced senior management to implement growth plan

As the objectives of business owners vary, so do the goals of participating principles. One element, however, remains constant: their focus on, and commitment to, the future success of the enterprise. The means, by which the ultimate goal will be reached, will depend upon the investor and the agreement of the partnership: it could involve internal growth, expansion through acquisition, or a combination of both.

THE PARTNERSHIP

Entrepreneurs who have functioned in the sole leadership role for many years may initially resist the idea of having a partner. While dealing with an individual investor may, indeed, require relinquishing some control, a partnership involving a private equity group is quite different: private equity groups are not interested in the day-to-day operations of the business, but rather in supporting management to achieve significant growth and profitability.

Clearly, the partnership resulting from a recap will achieve maximum profit through growth. After providing access to new capital, the financial partner is fully prepared to have the owners use their expertise and do what they do best – operate and grow the business.

Major decisions involving acquisitions or going public, are made jointly. Furthermore, the equity groups generally recognize the value of the owners unmatched expertise in their business and industry and will look to them for direction on important issues.